In the field of financial investing, a stop loss order is a conditional order placed with a broker to buy or sell a particular financial instrument once the instrument reaches a certain price. A stop loss order is designed to limit an investor's loss on a security position. For example, if an investor purchases several common shares of a given corporate stock at $50 per share, and immediately issues a stop loss order for $45 (10% below the purchase price), then if the price of the stock subsequently falls below $45 per share, the shares will be automatically sold by the broker at the prevailing market price.
The advantage of a stop loss order is that the investor does not have to monitor on a daily basis how a given stock is performing. The disadvantage is that the stop loss order could be activated by a short-term fluctuation in a stock's price. Thus, one of the important factors to consider when placing a stop loss order is picking a stop-loss percentage that will allow a stock to fluctuate day-to-day while preventing as much downside risk as possible. For example, setting a 5% stop loss order on a stock that has a history of fluctuating 10% or more per week will most likely result in the stock being sold at a loss. Additionally, once a financial instrument reaches the stop price, a stop loss order becomes a market sell order, and the price at which the financial instrument is sold may be significantly different from the stop price. This is especially true in a fast-moving stock market where stock prices can change rapidly.
Stop loss orders are traditionally viewed as a way to prevent losses. Another use of this tool, however, is to lock-in profits, in which case it is sometimes referred to as a “trailing stop.” Here, the stop loss order is set at a percentage level below not the price at which the financial instrument was originally purchased, but the current market price. If the price of a stock goes up, the value of the stock to an investor is an unrealized gain, because the gain is not realized until the stock is sold and its value is converted into actual currency. Using a trailing stop allows the investor to let potential profits increase, while at the same time guaranteeing at least some realized capital gain. To use the same example from above, assume an investor purchases several common shares of a given corporate stock at $50 per share. At a later point, after the price of the stock increases to $80 per share, assume the investor issues a stop loss order at 10% below the current price. The stop loss price is then set at $72 per share. If the price of the stock then falls below $72 per share, the stop loss order would automatically trigger a sale of the stock, thus preserving at least a portion of the investor's capital gains.
A stop loss order is a simple and effective tool for investors. However, it has limitations. First, a stop loss order is static. That is, it does not automatically advance with rising stock rates. Thus, if a financial instrument doubles in price, an associated stop loss order will remain fixed. An investor must take specific actions to increase or modify the stop loss order to account for a price increase. Another limitation is duration. A stop loss order is usually valid for a fixed period of time, usually one month. When the period elapses, the stop loss order expires and thus becomes ineffective at preventing future losses in the event a stock price subsequently drops. Accordingly, there is a need in the art for a system and method to automatically update stop loss orders under certain predefined conditions. Additionally, there is a need in the art for a system and method to automatically update individual conditions associated with pending conditional financial transactions.